Center for Law, Environment, Adaptation and Resources (CLEAR) Climate Change Risk Disclosure Current Practices and. Possible Changes Briefing Paper

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1 Climate Change Risk Disclosure Practices Report 1 Center for Law, Environment, Adaptation and Resources (CLEAR) Climate Change Risk Disclosure Current Practices and Possible Changes Briefing Paper Why Climate Change Disclosure is Necessary Economic losses due to climate change, such as losses associated with sea level rise, extreme weather, and climactic conditions like drought, are becoming impossible to ignore as the effects of floods, tornadoes, hurricanes, wildfires, drought and tsunami are increasing. 1 The impact of climate change, resilience or lack thereof to its consequences, and anticipation of policy and regulatory action signals that action must be taken to minimize and/or capitalize on these events. This is, in turn, driving the discourse on disclosing climate risk. 2 The lack of a standardized approach to climate change risk disclosure has resulted in a proliferation of disclosure and assurance regimes, leaving businesses, regulators, and investors with limited scope for comparing and assessing performance or identifying best practices. 3 The variety of approaches that can be taken means that investors and other stakeholders have difficulty comparing information across companies and sectors. 4 As a result, a few states have implemented mandatory reporting regulations for risk disclosure in certain circumstances. What Risks Are Generally Reported 1 Environmental Finance Publications, Corporate Climate Risk Disclosure: An executive guide to monitoring and disclosing climate risk 6 (Felicia Jackson ed., 2012), 2 Id. 3 Id. at Id. at 78.

2 Climate Change Risk Disclosure Practices Report 2 The Securities and Exchange Commission ( SEC ) defines effective climate risk disclosure in filings as systematic analysis of potential risks and opportunities related to climate change which are judged to be material. 5 Climate related risks and opportunities can be classified in several broad categories including: physical risks, emissions, financing and underwriting risks and opportunities, regulatory risks and opportunities, litigation risks, reputational risks, and indirect risks and opportunities associated with climate change. 6 Despite the number of different approaches and risks, in general, provisions that affect climate change-related disclosure fall into two main categories: (1) risk/governance reporting provisions that explicitly or implicitly require organizations to make disclosures in annual securities, company, or financial filings about management or governance of risks and strategies relating to climate change; 7 and (2) greenhouse gas (GHG)/energy measurement and reporting provisions that prescribe rules and/or reference standards and/or methodologies that directly or indirectly affect the way in which GHGs and energy consumption are monitored, measured, reported and/or traded. 8 Federal Approaches to Risk Disclosure Securities and Exchange Commission Disclosures The U.S. securities laws are based upon the principle that sound investments, efficient markets, and a stable national economy depend upon disclosure of significant information on firms financial conditions. 9 In February, 2010, the SEC issued guidance clarifying that existing 5 Jim Coburn et al., Disclosing Climate Risks & Opportunities in SEC Filings: A Guide for Corporate Executives, Attorneys & Directors 36 (Ceres 2011), 6 Id. at Id. at Id. 9 Id. at 12.

3 Climate Change Risk Disclosure Practices Report 3 SEC rules may require companies to disclose material climate-related information under Regulation S-K. 10 Existing S-K regulations under the Securities Act 11 require disclosure of the most significant factors that make an investment in the registrant speculative or risky because they are reasonably likely to have a material effect on the company s financial condition or operating performance. 12 The guidance recognizes that the disclosure requirements place particular importance on a registrant s materiality determinations and that the effectiveness of disclosures decreases with the accumulation of unnecessary detail or duplicative or uninformative disclosure that obscures material information. 13 The Supreme Court has explained that [a] fact is material [in SEC disclosures] if there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by a reasonable investor as having significantly altered the total mix of information made available, and that determining whether information is material requires delicate assessments of the inference that a reasonable investor would draw from a given set of facts, and the significance of those inferences to him. 14 The Court additionally instructed that doubts about whether information is material should be resolved in favor of those the statute is designed to protect, and has emphasized that disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. 15 Thus, the materiality standard is inherently fact specific and cannot be reduced to a simple formula, depending instead upon a careful review of a firm s particular circumstances. 16 As a result, according to the Commission 10 Commission Guidance Regarding Disclosure Related to Climate Change, 75 Fed. Reg (Feb. 8, 2010) C.F.R (2013). 12 Environmental Finance Publications, supra note 1, at Commission Guidance Regarding Disclosure Related to Climate Change, supra note 10, at TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976). 15 Id. at 448; Basic, Inc. v. Levinson, 485 U.S. 224, 234 (2010). 16 Jim Coburn et al., supra note 5, at 12.

4 Climate Change Risk Disclosure Practices Report 4 Guidance Regarding Disclosure Related to Climate Change, disclosure could be required under the Securities Act for any of the following parts of Regulation S-K: Item 101 of Regulation S-K requires companies to disclose material effects from compliance with federal, state, and local environmental laws. 17 This means disclosure of the costs a company has for its program of compliance with environmental laws that apply in addition to disclosure of material effects that compliance with those laws is expected to have on company business (in particular, on capital expenditures, earnings, and competitive position). 18 Item 103 of Regulation S-K requires disclosure of material pending legal proceedings against the company arising from federal, state, and local environmental laws. 19 These disclosure requirements apply not only to legal proceedings already initiated, but also to those a company knows are contemplated by governmental authorities. 20 No disclosure is required, however, if a claim for damages is less than 10% of company assets or if the monetary sanction from a governmental authority-imitated proceeding will not exceed 100, Item 303 of Regulation S-K requires disclosure known as the Management s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A. 22 This constitutes analysis and disclosure of material effects of known trends or uncertainties of company operation and financial conditions. This disclosure should highlight issues that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating performance or of future financial condition. As part of this a company must make its decision about whether climate change, or global warming, constitutes a known trend. 23 In the case of a known uncertainty, such as pending legislation or regulation, the analysis of whether disclosure is required in MD&A consists of two steps. 24 First, management must evaluate whether the pending legislation or regulation is reasonably likely to be enacted. Unless management determines that it is not reasonably likely to be enacted, it must proceed on the assumption that the legislation or regulation will be enacted. Second, management must determine whether the legislation or regulation, if enacted, is reasonably likely to have a material effect on the registrant, its financial condition or results of operations. 25 Item 503(c) of Regulation S-K requires a registrant to provide, where appropriate, under the heading Risk Factors, a discussion of the most significant factors that make an investment in the registrant speculative or a risk. 26 It specifies that risk factor disclosure should clearly state the risk and specify how the particular risk affects the particular 17 Commission Guidance Regarding Disclosure Related to Climate Change, supra note 10, at Id. 19 Id. 20 Id. 21 Id. at Id. 23 Id. 24 Id. at Id. 26 Id. at 6294.

5 Climate Change Risk Disclosure Practices Report 5 registrant. 27 Registrants should not present risks that could apply to any issuer or any offering. 28 Additionally, it should be noted that the Australian Stock Exchange ( ASX ) has implemented mandatory climate change reporting. 29 Entities listed on the exchange now must disclose whether they have material exposure to economic, environmental, or social sustainability risks. 30 If they do report risks, the exchange requires them to disclose how they plan to manage them. 31 Environmental Protection Agency Disclosures The Environmental Protection Agency ( EPA ) has authority derived from the federal Clean Air Act to regulate CO2 as a pollutant. 32 The EPA s reporting rule, issued on September 22, 2009, requires 31 source categories of GHG emitters to report the emissions of six categories of GHGs covered by the United Nations Framework on Climate Change. 33 The purpose of the reporting rule is to collect accurate and timely information on GHG emissions, which will be essential for informing many future climate change policy decisions. 34 The rule requires reporting, based on the type of industry or level of emissions, of three major categories of sources to report, including: 1) facilities that directly emit GHGs; 2) fossil fuel providers; and 3) 27 Id. 28 Id. 29 Climate Disclosure Standards Board, ASX Publishes New Corporate Governance Guidelines, Climate Disclosure Standards Board: News (Mar. 31, 2014), 30 Id. 31 Id. 32 Massachusetts v. EPA, 549 U.S. 497, (2007) (holding carbon dioxide to be a pollutant under the federal Clean Air Act); but see WildEarth Guardians v. EPA, 751 F.3d 649 (D.C. Cir. 2014); Washington Environmental Council v. Bellon, 732 F.3d 1131 (9th Cir. 2013) (illustrating EPA s broad discretion in creating regulations to fight climate change) Fed. Reg. 56,264 (Oct. 30, 2009) 34 Id. at 56,265.

6 Climate Change Risk Disclosure Practices Report 6 manufacturers of vehicles and engines. 35 It does not require the disclosure of material risks, such as that seen in the SEC filings. State and Industry Approaches to Risk Disclosure Although some information relating to GHG emissions and climate change is disclosed in SEC filings, much more information is publicly available outside of disclosure documents filed with the SEC as a result of voluntary disclosure initiatives or other state regulatory requirements. While New York has pushed for climate change risk disclosure through its own enforcement mechanisms tied to filings with the SEC, trade and investor groups have focused on seeking greater guidance from the SEC and on preparation of best practices guidelines through ASTM International. 36 California, on the other hand, is on the path to creating new laws requiring comprehensive climate change risk disclosure rather than waiting for federal comprehensive guidance. 37 New York has long been a front-runner in climate change risk disclosure. In September 2007, the New York Attorney General initiated an investigation into alleged incomplete disclosures by Xcel Energy and four other energy companies under the authority of the Martin Act. 38 As part of an eventual settlement, Xcel agreed to disclose the following information and analysis in its SEC 10-k filings for the next four years: (a) an analysis of financial risks from present and probable future regulation of GHG emissions; (b) an analysis of financial risks from GHG-related litigation; (c) an analysis of financial risks from the physical impacts of climate change (including increased sea levels and extreme weather conditions related to climate 35 Id. at James R. Williams and Christine M. Morgan, Financial Disclosure of Climate Change Risks: Recent Developments and a View of the Future 19 (2010), 37 Id. 38 Id. at 21.

7 Climate Change Risk Disclosure Practices Report 7 change); and (d) a strategic analysis of climate change risk and emissions management, including the company s current position on climate change, current and anticipated emissions management, and corporate governance actions concerning climate change. 39 This direct regulation of Xcel s climate change disclosure policies is remarkable due to the fact that Xcel provides no services within the borders of New York and the main activity prompting the action by the Attorney General occurred in Colorado. 40 Nevertheless, the Attorney General claimed jurisdiction under the Martin Act based on the fact that the New York State Common Retirement Fund was a significant holder in Xcel common stock. 41 Significantly, it should be noted that the Retirement Fund holds the common stock of over 2,000 American companies, each of which, under this theory, is potentially subject to Martin Act jurisdiction. 42 Additionally, since a large number of companies list stock on the New York Stock Exchange and on the New York-based NASDAQ exchange, a substantial number of American companies could possibly be subject to scrutiny by New York under the Martin Act. 43 Although this settlement was a voluntary decision to disclose, which set no legal precedent requiring heavy GHG producers to disclose climate change risk, it did show that thousands of companies nationwide are potentially at risk of enforcement, even though the scope of current requirements of climate change risk at the federal level is not fully developed. 44 Further, New York implemented a program in the middle of 2013 requiring insurers to fill out a survey detailing their climate change adaptation and mitigation strategies. 45 The requested 39 Id. at Id. 41 Id. 42 Id. 43 Id.; see also N.Y. Gen. Bus. Law 352 (2007) (forbidding misrepresentation in connection with the issuance of sale of securities in New York). 44 Id. at See NEW YORK DEPARTMENT OF FINANCIAL SERVICES, 2012 GUIDELINES AND SURVEY QUESTIONS: CLIMATE RISK SURVEY GUIDANCE (2012).

8 Climate Change Risk Disclosure Practices Report 8 information included mechanisms to address climate change impacts, but no quantitative data or future predictions were required. 46 California is another leader in climate change risk disclosure. Regulation of GHGs by major sources is required by the California Global Warming Solutions Act, 47 which requires the California Air Resources Board ( CARB ) to adopt a regulation requiring the Mandatory Reporting of Greenhouse gas emissions ( MRR ). 48 As part of this program, under certain qualifications, the qualified entities must report: emissions of GHGs from stationary combustion, process, and fugitive sources at the facility for each listed GHG; 49 a demonstration of every reasonable effort to obtain a fuel analytical data capture rate of 100% for each report year; 50 data used to assess the accuracy of emissions from each emissions source, categorized by process; 51 and quality assurance and quality control information including information regarding any measurement gaps. 52 California updated the scope of CARB in The update outlines specific goals for individual sectors, and sets assignment due dates for mid-range and long-term milestones of 46 See id. 47 A.B. 32, 48 Cal. Health & Safety Code D. 25.5, Pt. 2 (2006). 49 Cal. Code Regs tit. 17, 95103(a)(2) (2013). 50 Id. at 95103(a)(8). 51 Id. at 95103(a)(9). 52 Id. at 95104(b). 53 See CALIFORNIA AIR RESOURCE BOARD, FIRST CHANGE TO THE CLIMATE CHANGE SCOPING PLAN: BUILDING THE FRAMEWORK PURSUANT TO AB 32 (2014).

9 Climate Change Risk Disclosure Practices Report 9 reduction. 54 Additionally, the scope of California s climate change efforts has accommodated the findings of the new IPCC report on climate changed. 55 This will involve an 80% reduction of GHG emissions below the 1990 level to avoid the worse effects of climate change. 56 A number of additional states have enacted legislation that requires similar mandatory reporting of GHGs. All eighteen of the states which require mandatory reporting have joined the Climate Registry, which has set up a general reporting protocol which outlines required reporting calculation methodologies for the majority of GHG sources. 57 These protocols largely just require reporting of emissions and data use, similar to that required in the California MRR, rather than an assessment of material risks such as that seen in SEC filings. In 2014, the registry added additional emissions factors that must be reported, including coal coke, dry wood, landfill gases and other biomass gases. 58 Additionally, many of the calculated heat contents and CO 2 emission factors for materials were updated. 59 In 2012, after the wake of recent increases in catastrophic weather events, the New York State Department of Financial Services announced a joint initiative with the California Department of Insurance and the Washington State Office of the Insurance Commissioner to survey insurance carriers regarding climate change risks and the actions insurers are taking to address those risks. 60 As part of this initiative, insurers that write in excess of $300 million in 54 Id. at Id. at Id. 57 The Climate Registry, General Reporting Protocol v (2013), 58 THE CLIMATE REGISTRY, Table 12.1 U.S. Default Factors for Calculating CO2 Emissions from Fossil Fuel and Biomass Combustion, 1 (2014). 59 Id. 60 Sharlene Leurig and Dr. Andrew Dlugolecki, Insurer Climate Risk Disclosure Survey: 2012 Findings and Recommendations 4 (Ceres 2013) [hereinafter 2012 Survey]

10 Climate Change Risk Disclosure Practices Report 10 direct written premiums doing business in their states must disclose their climate-related risks. 61 As virtually every large American insurer operates in at least one of these states, the survey responses help give a good picture of how well prepared the industry is, as a whole, for the new risks associated with climate change. 62 Unfortunately, the results of the 2012 survey show that, in general, almost all participating companies show significant weakness in their preparedness to address the effects climate change may have on their business. 63 Only 23 out of the 184 companies were found to have a specific, comprehensive strategy to cope with climate change; 13 of those are foreign owned. 64 At best, it appears that most insurers view climate change as a risk that will inherently be captured in their Enterprise Risk Management strategies and at worst as an environmental issue immaterial to their business. 65 Few insurers describe efforts to engage stakeholders such as regulators, policymakers, customers, employees, asset managers or vendors on climate change, which limits the influence of insurers in shaping the public view of climate change risk. 66 Additionally, there appears to be a clear positive correlation between company size and the quality of insurer disclosure, as smaller companies tend to be far less prepared than larger companies in setting emissions targets or citing climate change related concerns. 67 In July 2014, a subsequent survey was conducted regarding the insurance industry s response to climate change the survey once again showed poor results. 68 The survey generated 61 Id. 62 Id. at Id. at Id. at Id. at Id. at Id. at Sharlene Leurig and Dr. Andrew Dlugolecki, Insurer Climate Risk Disclosure Survey: 2014 Findings and Recommendations 4 (Ceres 2014). [hereinafter 2014 Survey]

11 Climate Change Risk Disclosure Practices Report insurer responses, compared to 184 insurer responses in the 2012 report. Only 3 percent of insurers surveys achieved the highest ranking and only 10 percent have issued public climate risk management statements. 69 The survey also found that Property and Casualty insurers tend to account for climate change more than Life & Annuity and Health insurers. 70 The implications of these findings are profound, as the insurance industry is a key driver of the national and global economies and, if climate change undermines the financial viability of the insurance industry, it will have a devastating impact on the economy as well. As part of this survey, insurers disclosed risks such as: reputational risks, security risks, sustainability risks, energy efficiency risks, GHG emissions risks, extreme weather and physical risks, and emerging risks. 71 The respondents are given a score, which is kept private, based on their responses. 72 Voluntary disclosure mechanisms In March, 2010, ASTM International, one of the world s largest voluntary standards development organizations, released a standard guide suggesting a process for the identification, evaluation, and disclosure of financial impacts attributable to climate change. 73 The guide is intended for use on a voluntary basis by companies and agencies as a supplement to, rather than a replacement for, any applicable regulatory pronouncements, such as the interpretive guidance issued by the SEC. This voluntary reporting framework maintains that disclosure should be made when an entity believes its environmental liability for an individual circumstance or in the 69 Id. at Id. at Survey, supra note 60, at Id. at E Standard Guide for Financial Disclosures Attributed to Climate Change (ASTM 2011).

12 Climate Change Risk Disclosure Practices Report 12 aggregate is material. 74 Once financial impacts are determined to be material, the Guide directs reporting entities to make a variety of disclosures, including: information about the analysis performed by the reporting entity, which would include a discussion about both risks and opportunities considered and a discussion about management s position on and strategic activities related to climate change, as well as identification of who within the reporting entity s corporate governance structure is responsible for addressing these issues; 75 relevant regulatory requirements and their resulting financial impacts; 76 the likelihood, magnitude, and timing of the financial impacts, including disclosure of the techniques used for data measurement; 77 and estimated insurance or other recoveries or, if not available, an affirmative statement of that fact. 78 If a reporting entity believes that financial impacts attributable to climate change are so uncertain and speculative that no quantitative financial analysis can be performed, the Guide suggests that the reporting entity include a description of the types of financial impacts it foresees and its reasoning for determining that further quantitative analysis and disclosure is not currently feasible. 79 The Guide notes that while uncertainty cannot be eliminated, it is likely that at least some financial impacts can be assessed and quantified Id. at Id. at Id. at Id. at Id. at Id. at Id.

13 Climate Change Risk Disclosure Practices Report 13 Another leading voluntary framework today for climate related disclosures is provided by the Climate Disclosure Standards Board ( CDSB ). This framework includes climate risk reporting, which is defined as a qualitative assessment of the organization s exposure to current and anticipated (long-term and short-term) significant risks associated with climate change. 81 The CDSB s mission is to promote and advance more standardized disclosure of its Climate Change Reporting Framework, which was issued in The CDSB has been continuously working to improve their reporting guidelines. They have begun to collaborate with other major reporting organizations to improve uniformity and connectivity between standards. 83 CERES, who extensively reported on SEC s climate change reporting standard, has recommended the CDSB reporting framework to present better information to investors than the SEC standard. 84 The CDSB appointed the Carbon Disclosure Project ( CDP ) as its secretariat, responsible for conducting the day-to-day activities of the board in advancing its mission. 85 In the absence of a single unifying framework, the CDP has become a useful tool for finding out exactly what reporting takes place among the mix of frameworks. 86 The CDP found that the patchwork of legislation, standards, industry and program protocols, and guidelines that have developed to assist corporations to report on climate change share some fundamental characteristics. 87 In particular they found widespread agreement about the types of information 81 Environmental Finance Publications, supra note 1, at Id. 83 Climate Disclosure Standards Board, Corporate Reporting Dialogue Launched, Responding to Calls for Alignment in Corporate Reporting, Climate Disclosure Standards Board: News (Jun. 17, 2014), 84 Id. 85 Environmental Finance Publications, supra note 1, at Id. at Id. at 77.

14 Climate Change Risk Disclosure Practices Report 14 that a company should report in relation to climate change, including: (1) an analysis of the impact that climate change has or is expected to have on the financial and operating condition of companies and their ability to satisfy strategic objectives; (2) the way in which companies manage risks and opportunities associated with climate change; and (3) GHG emissions. 88 They have been very busy releasing papers on climate change resilience in Europe, American business s use of carbon pricing, and private sector climate change risk. 89 Emerging Trends/Recent Changes in Disclosure Practices Climate change and other sustainability issues will have a serious impact on the very foundations of businesses, including: the availability of inputs; reputation; efficiency; and customer and investor demand. 90 A better understanding of the risks and opportunities associated with GHG emissions and climate change would bring real benefits to business by enabling the development of strategies that can create value for organizations and their stakeholders. 91 Responses to the mandatory insurance survey as required by California, New York, and Washington show some common emerging strategies for risk management and disclosure. These include catastrophe modeling, reinsurance, higher deductibles or broader exclusions in risk-prone areas (particularly coastal zones), and a careful control of aggregate exposure, including rebalancing property with other lines of business. 92 Many insurers now model using warm sea surface temperature assumptions, consistent with current decadal warming cycles and with higher mean atmospheric and ocean temperatures driven by carbon forcing. 93 Of additional 88 Id. at Carbon Disclosure Project, Climate Change Disclosure Reports, Carbon Disclosure Project: Climate Change (2014), 90 Environmental Finance Publications, supra note 1, at Id. at Jim Coburn et al., supra note 5, at Id.

15 Climate Change Risk Disclosure Practices Report 15 interest is the growing tendency of insurers across business segments to prioritize physical risk management over carbon regulation risk management in their investments. 94 Based on responses received by the CDP from its annual survey of companies, it appears there is also an increasing appetite to change the annual reporting model to include metrics that reflect a company s exposure to all risks, including climate change. An emerging approach is Integrated Reporting which is showing the relationship between an organization s strategy, governance, and financial performance and the social, environmental and economic context within which it operates. 95 Research into recent corporate sustainability reporting also shows that companies are starting to respond to the demand for material information by using and including in disclosures materiality matrices as a means of showing how management has identified what is most important to the company. 96 In addition to growing trends, the International Integrated Reporting Council is leading the development of a global framework for corporate reporting that demonstrates the linkages between an organization s strategy, governance and financial performance, and the social, environmental and economic context within which it operates. 97 They released initial version of the Framework in December, The Framework uses a principles-based approach, with the intent to strike an appropriate balance between flexibility and prescription that recognizes the wide variation in individual circumstances of different organizations while 94 Id. at Carbon Disclosure Project, The Future of Reporting: CDP FTSE 350 Climate Change Report (2012), 96 Environmental Finance Publications, supra note 1, at International Integrated Reporting Council, Consultation Draft of the International <IR> Framework 1 (2013), 98 Id.

16 Climate Change Risk Disclosure Practices Report 16 enabling a sufficient degree of comparability across organizations to meet relevant information needs. 99 The Sustainability Accounting Standards Board ( SASB ), a U.S.-based, non-profit organization, intends to establish industry-based sustainability standards for the recognition and disclosure of material environmental, social and governance impacts by companies traded on U.S. stock exchanges. 100 The SASB sees itself as the non-financial counter-part to the Financial Accounting Standards Board in the U.S. and plans to issue a complete set of standards covering 10 sectors and 102 industries by Any shift seems to be centered on private industry gradually accepting climate change risks into their investment portfolios. 102 Businesses are slowly seeing climate change to not only be a future risk, but also opportunity of which they can take advantage. 103 One of the main areas of concern, however, is uncertain future regulatory results. 104 Additionally, this report has uncovered many technical changes to reporting requirements, such as sources to be included in greenhouse gas modeling and the amount of emissions per unit energy of a material (as mentioned above). 99 International Integrated Reporting Council, International <IR> Framework 4 ( Dec. 2013), Sustainability Accounting Standards Board, Id. 102 Climate Disclosure Project, State by State: The business response to climate change across America, CDP: Driving Sustainable Economics, 3 (2014). 103 Id. 104 Id.